Sunday, December 26, 2010

Credit Risk

Credit risk is essentially the possibility that a bond issuer may not be able to make interest payments or principal payments to bond holders. Credit risk refers largely to a deteroriation in the financial performance and cash flow profile of the borrower or counter-party. Credit risk can also exist in other financial contractual arrangements e.g. derivatives - however that risk is more specifically called counter-party risk, i.e. the risk that the other party to the contract becomes financially unable to meet their obligations. When the market perceives an increase in credit risk for a company e.g. bad earnings announcement or credit rating downgrade, the market yield on that company's bonds will increase (meaning a drop in the bond price) to reflect the greater level of credit risk.

Synonyms: Default risk, Credit spread, Counter-party risk
 
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